Work and Leisure in the US and Europe: Why so Different?

1. Why Do Americans Work So Much More Than Europeans? Work and Leisure in the US and Europe: Why so Different? Prescott, Working paper Google scholar cites: 358 Alesina, Glaeser and Sacerdote, Working paper

2. Summary • Americans now work substantially more than Europeans; wasn’t true 40 years ago • Prescott studies a simple representative agent model • Finds that taxes can explain all the differences in labor supply • I will augment Prescott’s work with other info, especially from Alesina, Glaeser and Sacerdote (henceforth AGS, 2005) • Also, some cameos by Dew-Becker and Gordon, 2007

3. US vs EU E/N

4. Raw Data for Hours Per Employee

6. The basic facts • European labor supply fell throughout the postwar period • Both intensive and extensive margins • EU labor productivity caught up to the US • Output per capita never gained • Prescott’s question: what explains the changes in employment?

7. The theory • Standard RBC framework, • Where c is consumption, h is hours • Highly stylized, but a reasonable starting point • Unit IES, no wealth effects on labor supply • α is key in determining labor supply

8. Budget Constraint: • tc, tax on consumption • tx, investment tax; x investment; δ depreciation • th, marginal tax on labor • tk, capital income tax • Tt, transfers; Gov’t gives all the tax revenue back • The key is the price of consumption relative to leisure; depends on tc and th

9. Key equilibrium conditions • Labor supply: • Wage: • Elasticity of hours wrt wages: • Prescott calibrates α to match the average level of employment • Elasticity is 0.77 • This is roughly the same number one gets by regressing employment on taxes

10. Labor Taxes in Europe

12. Taxes on second earners • Labor supply increase in the US between ’70 and ’93 is entirely driven by married women • Single women are a small part of the working age population… • 1986 tax reform reduced taxes on second earners (see next slide) • A similar reform in Spain raised labor supply by 12 percent

14. AGS on labor supply elasticity • Note that α governs both the level of employment and the elasticity wrt taxes • The elasticity is zero if you have no unearned income • Prescott’s η=0.77 • Labor literature says • ηmen ≈ 0 (upper bound 0.35) • ηwomen ≈ 1 • AGS argue taxes explain at most half the gap between US and Europe

15. E/N Ratio to the US

16. Male Employment Effect of the Policy variables (1.47%) Effect of the post-95 dummy (6.32%)

17. Female Employment Effect of the Policy variables (1.75%) Effect of the post-95 dummy (2.38%)

18. AGS’s Alternative Hypothesis • One way to read the results is that there is a big macro elasticity but a small micro elasticity • Maybe there are complementarities that magnify micro effects • AGS argue for complemetarity in leisure • We all coordinate on the weekend • Women happier staying home if they have friends • We want vacation at the same time • Then unions and gov’t may have a place in solving coordination problems • Prescott may be right for the wrong reasons

19. The Social Multiplier • A social multiplier assumes that the value of leisure depends on the leisure taken by others • Social multiplier means V12>0 • Let • Then the social multiplier is 2v1/(2v1-v2) • v1>v2 implies social multiplier < 2 • Too small for micro elasticities to account for macro regressions

20. Some suggestive evidence • People take weekends off together • People tend to work 9–5 instead of staggering shifts • Holidays are grouped together • Social multiplier might come from increasing returns in work (e.g. Ciccione and Hall)

21. However, AGS settle on 0.2 as a reasonable micro estimate of LS elasticity • A maximum social multiplier of 2 implies a macro elasticity of 0.4 • The 0.2 estimate probably includes multiplier effects already anyway • Prescott overstates the case – taxes explain at best half the LS difference • And for him to be right, unions and hours limits must be optimal!

22. What are the alternative explanations? • Many policy differences between EU and US • Implicit taxes on earnings after retirement age • Unemployment benefits • Tax rates on second earners • Employment protection legislation • Product market regulation • If Prescott is right, they don’t matter

23. Employment Protection Legislation

25. A policy proposal • Suppose we take Prescott’s parameters as given • I.e. the macro elasticity is causal, maybe due to a social multiplier • Now we can go from a pay-as-you-go to fully funded social security • Not possible with fixed labor supply • Proposal: allow people to lower their tax rate by 8.7% and put it in a retirement account • Intuition: leads people to work substantially more • This only works by stopping redistribution

26. Sets up a big OG model: • Wages grow at 2% per year • People work from age 22 to 63 • SS benefits equal 32% of wages at retirement • Prevailing marginal tax is 40% • Then simulates the effect of the proposed policy change

27. The effects of employment on productivity • Historically, productivity tends to grow quickly when labor is scarce • Habakkuk hypothesis • Clark paper on cotton mills • US postwar experience • Does this explain the recent experience of Europe? • Employment rises post-1995, but productivity slows

28. Productivity Regressions • Instrument for employment changes with labor taxes • Coefficient on employment is twice what we would expect • EPL and ARR have independent positive effects on productivity

29. Conclusions • Prescott is provocative • Nice implementation of a canonical theory • AGS show that his results are probably too strong • Taxes explain at most half the variation in LS • Why rule out all the other things Europe does wrong? • The strong macro elasticities imply policies limiting employment may be efficient

30. Labor’s share of income

31. Labor’s share of income